What is a Self-Directed IRA?

Self-Directed Individual Retirement Account (SDIRA)

A self-directed Individual Retirement Account (SDIRA) is an IRA account
that provides you the flexibility to invest in a wide variety of assets
outside the traditional options such as stocks, bonds, mutual funds, and
ETFs available for investment through an Individual Retirement Account.
SDIRA is not a new phenomenon – it has been around since 1974 in the tax
code when IRA options were introduced. It allows for the same tax benefits
that are available to Traditional or Roth IRA.

The reason people get attracted to SDIRA is the opportunity to invest in
assets like real estate, cryptocurrencies such as Bitcoin, precious
metals, loans, private companies, etc. Considering alternative assets
have provided good returns to some of the most sophisticated investors
like pension funds and endowments, most investors look to a SDIRA to
improve their returns.
The list of available options here is not exhaustive. The Internal Revenue
Services (IRS) provides a list of investments that you cannot invest in
instead of publishing a list of options available for investing.
As per IRS guidelines, an investor cannot use SDIRA to invest in life
insurance or collectibles. Here are some examples of collectibles:
* Artwork,
* Rugs,
* Antiques,
* Metals – with exceptions for certain kinds of bullion,
* Gems,
* Stamps,
* Coins – (but there are exceptions for certain coins),
* Alcoholic beverages, and
* Certain other tangible personal property.
Interestingly even gold and other bullion are considered “collectibles”
under the IRA statutes and you cannot hold these in your SDIRA account
unless it is highly refined bullion and in the physical possession of a
bank or an IRS-approved nonbank trustee

The most common asset class in a SDIRA is real estate as it’s probably the
easier to follow provided enough research and due diligence has been done
to select the right real estate portfolio. The one thing you have to keep
in mind is not to breach the IRS self-dealing rule. A couple of examples
of self-dealing are:
1. Don’t rent your own property
2. Engage a third party if and when the property needs repair or any other
work and don’t engage in fixing the property.

What happens if you breach this rule: the benefits of IRA will go away from the start of that year and if it’s a Traditional IRA you will be subject to a 10% penalty.

So why should you bother investing in SDIRA?
1. Diversification: Traditional IRA offers only stocks, bonds, mutual funds, ETFs and similar assets. You can get exposure to other assets like
real estate, Bitcoin, private companies through SDIRA.
2. Better returns: Although it’s hard to predict the returns of any asset class, most people get attracted to SDIRA to generate better returns as
compared to those generated through publicly traded options available
through IRAs.
3. Investing in an asset class you have experience with If you know more
about an asset class than the average investor (for instance,
cryptocurrency), it may not be a bad idea to allocate some of your
retirement money to that portfolio.

What are the challenges?
• Limited providers: Household names don’t provide self-directed IRA
options, therefore you need to do some research to find a custodian that
suits your need. It is unlikely you will find one that offers you multiple
assets (loans, real estate, private companies, cryptocurrency, etc.) under
one roof.
• Liquidity: The account is meant to invest for the long term and for
retirement but if there is a need for liquidity it may not be as easy as
selling stocks, bonds or mutual funds in the public market. Most options
available in self-directed IRA are not liquid and it will not be easy to
convert them into cash immediately if there is a need.

• Risk: Higher the return, the higher the risk. If you invest in
self-directed IRA, say in Bitcoin, the volatility of that asset class is
currently higher than other asset classes and therefore although it has a
potential for earning higher returns, the risk is higher too.
Lack of information and higher cost: You need to do spend a
considerable amount of time in performing due diligence to understand the
ins and outs of the asset you are investing in. Usually, the cost
associated with opening SDIRA is higher compared to simple IRA accounts as

Considering the significant effort involved in investing in SDIRA, our
recommendation is to proceed only if you are committed to taking the time
to understand the asset class you want to get exposure to through your
SDIRA account.

Source: https://www.irs.gov/publications/p590a

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